Independence Lost

I have written on several occasions about some of the primary risks facing the retirement plan industry. Chief among them may be the loss of independence among those that retirement plan sponsors depend on - fiduciary consultants.

Retirement plan consulting is a professional service. More akin to an accountant or an attorney than to an investment manager. The benefits of the professional service model are clear: attention to client needs, independence, customization, and attention to detail. The limitation of this service is the scale. Marginal administrative and marketing expenses may decline as an organization gets larger, but there is a limit on how many clients a strong consultant can effectively serve.

Contrast that to a manager of an investment product. An investment manager manages a pot of money for clients. As the pot gets larger, the costs remain fixed, but the revenue grows, increasing profitability with size.

Over the past few years, private equity and other outside investors have entered the retirement plan industry, acquiring retirement plan consulting firms by “rolling up” small providers into larger organizations. Private equity firms believe they have solved the scale limit. Don’t behave like a consultant, behave like an asset manager.

We are seeing the beginning of a trend that may erode the confidence in fiduciary consultants for a generation, wherein firms coop the language of independence to sell trusting clients products upon which they are compensated.

The recent proliferation of Adviser Managed Accounts is a classic example.

Managed accounts in retirement plans have been available for some time. Originally sidecar services offered by large plans, as technology has improved and generations have become more comfortable with automation, the prevalence and use of managed accounts has increased significantly.

While they have been around for some time, managed accounts never gained widespread attraction. Why that might be can be debated, but one undeniable factor in that was that many fiduciary consulting firms had a skeptical eye on the high fees and indeterminate value that managed accounts may provide participants.

The interest of some firms to serve as an asset manager rather than a professional service provider created an opportunity to grow managed account adoption. External managed account providers saw an opportunity to co-op the gatekeeper role that the consultants played by integrating consulting firms into the managed account process. While historically the managed account provider was both a technology solution and fiduciary investment manager, “advisor managed accounts” became a new offering. Advisor managed accounts allow the managed account provider to provide the technology while the fiduciary consulting firm can provide the investment advice, adding a new revenue stream for retirement plan consulting firms.

Under most advisor managed account models, the technology is provided by the managed account provider. The recordkeeping firm delivers the trading connectivity and offers the solution to plan sponsors. Advisors are then permitted to populate the array of models and collect a fee serving as the fiduciary to the models they’ve created. In a typical model, the technology provider may be entitled to 0.10% to 0.15%, the recordkeeper another 0.10%, and the advisor may tack on another 0.10% to 0.20%

The birth of advisor managed accounts is a critical example of where independence can be lost in the pursuit of profit and revenue. It is generally accepted that the recordkeeper does not have a fiduciary role to the plan and the managed account service provider is trying to distribute their product to as many participants as possible. Most plan sponsors have looked to their consultant for advice in evaluating these types of solutions but now that consultant has a financial conflict with interests that are not aligned with the client they are advising.

Managed accounts can be an effective tool in providing more tailored asset allocation solutions to participants. Managed accounts can also be a tax on unengaged participants who wish to delegate the investment selection process. However, with everyone lined up to receive the proceeds of managed account revenues, the plan sponsor will ultimately be the one left in depositions when litigation comes.

Managed account litigation is already here (Kellogg, Dover, Nestle). However, these cases lack the higher conflicts that the advisor managed account market creates. In these cases, the sponsors picked a third-party managed account provider, standing next to an unconflicted consultant. Advisor managed account litigation will follow. We have seen similar litigation where fiduciary consultants recommended investment products that they created. When it arrives, the risk will lie with the sponsor, who has executed an agreement severely limiting the liability of any of the related players.

For years, states have used lottery programs to pay for services that they wouldn’t raise taxes to fund. As a result, a relatively small number of people who play the lottery end up footing the bill for everything from schools to parks, benefiting all of us. Recordkeepers, and increasingly, investment consulting firms, are doing something similar. Rather than charge a fee that allows them to provide the necessary, independent services clients require, they imbed managed accounts with obscured revenues to subsidize the work and imbed a conflicted profit motive.

The conflicts are clear, but in the words of Upton Sinclair, “It is difficult to get a man to understand something when his salary depends on his not understanding it.”

Recordkeepers are pandering to investment consultants to offer these solutions, thereby increasing the likelihood of their winning recordkeeping engagements. Investment consulting firms are then heavily endorsing and marketing the solutions to the participant in their plans, and so it goes.

I was speaking to a recordkeeper recently. They are one of a small number of national firms not currently offering advisor-managed accounts. They recounted recent discussions with private equity-funded retirement consulting rollups, where they’ve been told they won’t be included in RFPs for recordkeeping without an advisor-managed account wherein the consultant could be paid.

For now, the trend continues. But, if it’s a trend fueled by self-interest rather than a participant's best interest, I expect it will end poorly.

Multnomah Group is a registered investment adviser, registered with the Securities and Exchange Commission. Any information contained herein or on Multnomah Group’s website is provided for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies. Investments involve risk and, unless otherwise stated, are not guaranteed. Multnomah Group does not provide legal or tax advice.

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